"The Bank of England has some explaining to do."

Willem Buiter considers the B of E dropping rates:

"The Monetary Policy Committee of the Bank of England obviously subscribe to the dictum (often attributed to Keynes) “When the facts change, I change my mind - what do you do, sir?” They cut Bank Rate by 150 basis points to 3.00 percent. In contrast, the ECB cut its official policy rate by a mere 50 basis points to 3.25 percent. For the first time since the euro area was created on January 1, 1999, the official policy rate in the UK is below that in the euro area.

Despite being pleased with this bold move by the MPC, I feel a bit of an idiot. On October 26 I had called for a cut of between 100 and 150 basis points in my Financial Times blog Maverecon. Yesterday, after the horror show of the PMI services survey, I argued for a 150 basis points cut in an interview on the Daily Telegraph’s Telegraph TV. My prediction of what the MPC would do was not the same, however, as my recommendation of what it ought to do. I predicted a 100 basis points cut."

Maybe he should start a hedge fund. Anyway, he approves.

Here's my comment:

“We are also likely to need much more capital injected into the banks. The case for mandating a large tier one capital ratio increase (to 11 or 12 percent, say) for all banks by a certain date (soon!) is becoming stronger every day. The evidence is mounting that banks now may have enough capital to survive but not enough to be willing to lend to households and non-financial businesses. Fear, conservatism, excessive caution and timidity have taken over from reckless lending and the dominant driver of bank behaviour. The bean counters are in charge.

Mandating the capital increase is essential, as most banks will not be able to attract the required additional capital from the markets (or might not be willing to do so, even if they could). The government will have to make up the difference in exchange for ordinary shares or convertible preference shares. Without the government mandating these further capital increases, banks may choose to remain undercapitalised rather than risk losing their independence.”

I though that you and I preferred that the banks remain private, if possible. Is the threat of under-capitalization insolvency, with further government money to prop them up, or are you assuming that if they have more capital that they will lend more?

I take you to be saying that it’s the latter, but if they’re private banks, how can they be mandated to lend? Here, in the U.S.,under Tarp, we’re having trouble getting banks to “deploy” the money that they’ve directly received from the government. And, as opposed to Bernanke’s rule that a stimulus should be used when things are rough, the banks here have seemed to given up on that, and aren’t inclined to lend until the coast is clearer. In other words, what’s to keep banks from on sitting on their capital and waiting for a better environment to invest?

Posted by: Don the libertarian Democrat | November 6th, 2008 at 10:01 pm

So Buiter thinks this is a brilliant move. Not Peston on BBC:

"The Bank of England has some explaining to do.

In September, it said there was a case for raising interest rates - that there was a risk inflation would remain above the 2 per cent target.

Since then, the Bank of England has cut interest rates by two full percentage points, including today's cut of 1.5 per cent - a bigger cut by far than any it has made since it took full control of setting what's known as the official Bank Rate.

And in slashing that interest rate, it said there was now a serious risk of inflation undershooting its target - because the economy is shrinking so rapidly.

How on earth - you might ask - could economic conditions change quite so fast?

How could inflation be the worry in September and a deep dark recession be the fear today?

Is it possible that just two months ago the Bank of England failed to assess properly the weakness of the economy.

This really matters - because the Bank of England's success for a decade after 1997 in controlling inflation and providing a firm foundation for stable economic growth stemmed in part from its credibility.

But then this:

"The IMF has tonight published a forecast that the British economy will shrink by 1.3 per cent in 2009. That's a full 1.2 percentage points worse than the prognostication made only a few weeks ago by the ambulance service for the global economy.

That deterioration in our economic prospects helps to explain why the Bank of England has acted so decisively today.

But the IMF is also predicting that the performance of the UK will be the worst of the developed economies - which puts more pressure on the Bank of England to explain why it was inappropriate to make such a cut in interest rates rather earlier in the autumn."

Okay, it makes sense, but I think Peston's larger point is correct:

"If the Bank's judgement were no longer trusted, its ability to do its job - to control inflation - would also be seriously impaired."

One can be impressed with the Fed"s and B of E's gyrations, but it's prescience is in doubt.

See my post here.